Are Annuities Safe? Exploring the Multiple Safety Nets of Fixed Annuities

When it comes to the question of "are annuities safe?", many people are genuinely unsure, pointing to the investment risks associated with market performance. Fortunately, annuities come with multiple 'safety nets' that, while not risk free, deter complete financial disaster.

1st Safety Net - Insuring Your Assets

You insure your house, your car, your health, and your life – why not your retirement portfolio? Especially since your retirement portfolio’s ability to stay safe and generate a guaranteed income stream during retirement is what allows you to afford to maintain all those other insurances to begin with.

When your money is deposited with a fixed annuity, your principal and interest are contractually guaranteed in writing and backed up by the full strength and claims-paying ability of the insurance company. By using an insurance company with a high strength rating, that means in most instances you are backed by a company with billions or dollars in assets and reserves that may also be between 50 and 150 years old.

Annuities can provide a death benefit provision, allowing you to leave a portion of your annuity payment to a beneficiary. Customization options for annuities may include inflation protection, death benefits, and withdrawal riders. Annuities suit those prioritizing guaranteed retirement income and tax deferral, but require careful evaluation of costs and complexity to ensure they meet your needs. Consulting a financial professional can help ensure that an annuity meets your needs and expectations.

2nd Safety Net - Company Ratings by Independent Rating Agencies

All insurance companies are heavily scrutinized by the major independent rating agencies: Fitch, Moody’s, Standard and Poor’s, and A.M. Best. Each rating agency differs slightly in their criteria and manner in which they assign a letter grade to an insurance company.

Founded in 1899, A.M. Best is the oldest of the four agencies and tends to be widely recognized as the most trusted and accurate. A.M. Best’s Financial Strength Ratings (FSR) represent the company’s assessment of an insurer’s ability to meet its obligations to policyholders.

The insurance carrier you choose matters for the safety and reliability of your annuity, as their financial strength directly impacts your investment. The rating process involves quantitative and qualitative reviews of a company’s balance sheet, operating performance and business profile. This including comparisons to peers and industry standards, and assessments of an insurer’s operating plans, philosophy and management. For the latest insurance company ratings access the AM Best website.

There are many annuities available, so it is important to evaluate the insurance carrier's ratings before making a purchase. The ratings scale includes 15 different ratings:

1. A++ (Best)

2. A+ (Superior)

3. A

4. A- (Excellent)

5. B++

6. B+ (Good)

7. B

8. B- (Fair)

9. C++

10. C+ (Marginal)

11. C

12. C- (Weak)

13. D (Poor)

14. E (Under Regulatory Supervision)

15. F (In Liquidation)

These ratings are very helpful in determining which annuities are safe investments. Choosing a highly-rated insurance company can help mitigate the risk of claims-paying ability impacting your income stream.

3rd Safety Net - Insurance Company Regulations & Reserve Requirements

All insurance companies are regulated by individual state insurance departments. The job of these state commissioners is to be constantly reviewing, monitoring and auditing the internal investment holdings, reserve requirements, and overall strength and solvency of the company.

Each state requires that every life insurance company doing business in its state must have enough liquid assets to cover the insurer’s current and future obligations, plus a little extra. When you deposit money at your local bank, the banker may only be required to hold between 5-15% of your deposit in reserves. The rest can be used and lent back out for profit.

When you deposit with a fixed annuity, the company is required by law to set aside a minimum of $1.04 for every $1.00 of principal that you deposit. That means 104% of your deposits are held in reserves instead of only 15% with most banks, and many insurance companies actually have much more than just the minimum reserves. Fixed annuities are considered a secure type of annuity that offers a guaranteed fixed interest rate, providing predictable investment returns regardless of market conditions.

The account value of a fixed annuity is protected by these reserve requirements, which helps maintain stability even during market downturns.

4th Safety Net - Historical Track Record

Just the North American insurance industry alone is comprised of around 2,000 individual companies, who collectively own, control or manage more assets than all the banks and oil companies in the entire world combined. It has been said that if there were ever a financial collapse in this country, the insurance industry would be second only to the U.S. Government to fold, and that is only because the government has the ability to tax and print money.

The insurance industry also has by far the best strength and stability record of any financial institution over the past 150+ years. Even Babe Ruth, the legendary baseball player, was able to financially survive the Great Depression because the majority of his retirement savings were in fixed annuities. He never lost a dime due to market fluctuation in his fixed annuities, while many of his teammates went bankrupt from the market crash.

Annuities are generally considered safer for principal preservation than stocks, but they provide less liquidity. Returns from annuities may lag behind other investment options, particularly those with higher risk profiles like stocks or mutual funds. Investing in the stock market, such as through the S&P 500, can yield higher average annual returns compared to annuities, but with greater exposure to market risk. Mutual funds can provide higher potential returns than annuities, but they also carry more risk, while bonds offer a middle ground between the security of CDs and the riskier stock market investments, similar to annuities.

Deferred fixed annuities allow your premiums to grow on a tax-deferred basis until you begin receiving payments, and fixed index annuities are tied to a market index, such as the S&P 500, offering potential for higher gains while protecting your principal. Some retirement accounts, like 401(k)s and IRAs, may offer tax advantages that annuities do not, and annuities can be a useful way to invest, particularly since they are tax-deferred products.

Annuities can be structured to provide income payments for a predetermined number of years or for the rest of your life, depending on your needs and life expectancy. The overall returns from annuities can be affected by fees, surrender charges, and other costs, so it is important to seek advice from a financial professional to ensure the product makes sense for your situation. The value of annuity payouts may change over time due to inflation or other factors, so it is important to consider what could happen in the future when planning your retirement income.

5th Safety Net - State Guaranty Associations

When planning for retirement, it’s smart to consider every possible safety net for your savings. One important layer of protection that often goes overlooked is the state guaranty association. These associations act as a financial backstop, stepping in to protect policyholders if an insurance company is unable to meet its obligations due to insolvency. This means that, even in the unlikely event of an insurance company failure, you can still count on receiving your guaranteed income stream —up to a specified amount, which is typically $250,000 per policyholder, per company, though this can vary by state.

These associations are funded by insurance companies themselves, not by taxpayers, and are designed to provide confidence and stability in the insurance industry. However, it’s important to note that this protection is subject to certain limits. If you have multiple annuities with the same insurance company, your total coverage may be capped at the state’s specified amount. To mitigate this risk and maximize your protection, one of the best ways is to diversify your annuity purchases across several highly rated insurance companies.

When evaluating an annuity, don’t just look at the features and potential growth—also check the financial strength of the insurance company through independent rating agencies. This step helps you assess the company’s ability to perform and meet its promises, especially in the event of unexpected changes in the financial markets. Additionally, consider seeking advice from a financial professional who can help you evaluate your risk tolerance, balance your retirement accounts, and select the right mix of fixed and registered index linked annuities to meet your long-term goals.

While not a substitute for careful planning, they do provide an added layer of protection that can help you build confidence in your retirement strategy. By understanding how these associations work and taking steps to diversify and evaluate your annuity providers, you can better protect your retirement savings, mitigate longevity risk, and ensure a steady income stream for your future. In addition to the contractual guarantees and strong regulatory oversight already discussed, these associations offer another means to help you sleep soundly, knowing your retirement income is backed by multiple safety nets.

Conclusion: Are Annuities Safe?

The answer is: absolutely yes! While there are considerations that one might some professional guidance over, annuities are an investment option that are designed to provide guaranteed income payments and financial stability in retirement.